If you find yourself faced with the opportunity to buy an already established business there are many things that you need to consider, and questions that need asking, before signing on the dotted line.
This is according to Mary-Anne Greisdorfer, an Associate Director in the audit division of BDO Cape Town who says that amongst many things one must think about liability, the valuation of the business, your timeline and your exit strategy. Before you even consider buying a business or taking a partnership, here are some basic questions to ask:
1. Have you analysed the financial records?
Greisdorfer advises that you analyse the financial records for the past 3 years, including balance sheets, profit and loss statements, tax returns, purchases and sales records and bank statements. “Also to check that these records been well kept and if they show potential for growth?
“The financials form the basis of everything, and your assessment of these is the first point of business as you want to ascertain the viability and profitability of a business before proceeding. Being able to review a fully audited set of financial statements is first prize,” says Greisdorfer. “Second to this, if audited financials are not available, is a compilation of the financial statements. You must also ascertain who did the audit or who put together the compilation – ensure it is a reputable firm with a strong track record. Also be sure to ascertain what accounting framework they use.”
2. Have you assessed the tax implications?
“You're buying an asset and at some point in the future you may wish to sell it so make sure you are aware of the relevant provisions of capital gains tax law,” says Greisdorfer. “Also, there may be Securities Transfer Tax (STT) implications if you acquire business assets in the form of buildings or if you buy the shares in the business there will be security transfer tax, so make sure you have considered these.
3. Why is the seller really getting out?
“Take the time to ask the seller about why they are selling. Build a relationship with the seller and be thorough in your due diligence."
4. Who is steering the ship currently?
Like a ship’s captain, a company's CEO or management team steers, rights and can sometimes sink the ship, so it's important to know who the company's management currently is before you buy.
“Ask things like: Is the company's success heavily tied to this person/these people? Do you feel comfortable that the business can do well if that person/those people leaves the company?” says Greisdorfer.
5. What business model does the company employ?
“What business model/strategy does that business use to maximize its profit? For example, does it offer the lowest possible price so it can sell more products or does it sell fewer, higher-quality items but earns a larger profit per product sold.”
6. Do you have a competitive advantage?
“Do you have a competitive advantage – either through superior products, patents, brand power, technology or operating efficiency? Ask what is unique about this business's product or service?”
7. How does the business make its phone ring?
“Obviously, any business needs to have a growing customer base to be successful,” says Greisdorfer. “So it is important to know what marketing the business has engaged in and what was successful versus what was not. Also ask if the product or service is likely to maintain or improve its marketability or is it in danger of becoming over-sold, out of style or obsolete?”
“Also do some market research and see what the public perception is of the business - don’t just take the word of the seller.”
8. Is the revenue on the up?
Revenue is simply the amount of money the business made from the sales of its product or services. “While it's not realistic to expect a company to increase its sales every single year (especially in a struggling economy), a company with a trend of falling annual revenues signals it has troubles.”
Greisdorfer advises that one must try and ascertain what are the sales patterns year-by-year and month-by-month and if there is a seasonal pattern or one related to a business cycle.
9. Are the profits increasing?
Profits or net income is the amount of money a company earns from sales after expenses and taxes have been paid. “A company with growing profit each year shows that the business is successful, but have you considered the effect of inflation on sales and costs in the years to come?” asks Greisdorfer.
“Also look at year on year trends in expenditure and ascertain things such as if the business has been cutting costs to boost profits? Are there maybe unrecorded liabilities that would understate the expenses to boost profits? Is the business carrying more stock at year end as this reduces the cost of sales numbers and thus increases profits.”
10. How much debt does the business have?
“It is important to do a debt-to-equity ratio analyses which will help you ascertain how much debt a company carries compared to the amount of equity held in the business. This indicates how well the business can repay its debts if it should run into serious financial problems. Generally, the lower the debt-to-equity ratio a company has, the less risky it is to you as a buyer.”
11. Turn around time on stock and payment to suppliers
“Another important factor is to assess if the business carries high volumes of stock, and what the turn-around time between stock being sold and the sale/debtor paying is. “There may possibly be a cost/financing element for the investor who is buying the business with regards to when they need to pay the supplier. The investor will then need to have spare funds available or get financing to cover the difference between suppliers being paid and money from debtors coming in.
12. Are you savvy about the legalities?
Greisdorfer says it is important to ask questions like what are the terms and conditions of any applicable lease agreements and your obligations and rights under such agreements? Are there any legal proceedings pending against the business or the seller? Have you sought legal and accounting advice on the best way to handle your finances, the purchase and your business structure?
13. What is your exit strategy?
“This is an important question to ask even as you make the decision about whether to buy a business or not,” says Greisdorfer. "This should be considered right from the start. You should also have a buy-sell agreement in place if you happen to have any partners involved in the business.”
“There are so many other things that can be assessed before committing to buying a business,” says Greisdorfer. “Such as how old the machinery is (if applicable) and if it will need replacing any time soon and at what cost? How much stock needs to be carried to meet demand? Are you satisfied that the expenses disclosed include all expenses incurred by the business? Has the seller covered the business with the necessary insurance cover? Have all compliance requirements (Work Health and Safety, Quality Assurance and Environmental compliance) been met and do they appear in the accounts? Are any goods on warranty? If so, should you make a financial allowance for possible warranty commitments? The list can almost be endless and that is why it is important to consult with a financial expert who can guide you through the process.